You’re the Voice, But Don’t Understand It

The week began with the world’s big wigs making all sorts of statements. Kitchen sinks were being thrown by economist Paul Krugman. Columnist Ambrose Evans Pritchard announced the US is “trapped in a depression”. And European Central Bank chieftain Jean-Claude Trichet claimed decreasing deficits would lead to economic growth (sound familiar?) Keynes would be turning in his grave at hearing all this. It’s safe to assume he can’t. (Hear it, nor turn in his grave.)

But people listening can’t help hearing all this noise. And it needs dissecting, filtering and analysing. So, here goes…

“At a time when European countries such as Germany are calling for austerity measures to rein in budget deficits, Krugman is calling for more stimulus to prevent a repeat in the U.S. of Japan’s decade of economic malaise in the 1990s.”

Looking at Japan’s government debt growth in that time, it seems more than the kitchen sink was thrown by Japanese governments. But anyway, there are still deeper issues with Krugman’s history lesson:

“I’m not aware of any example of a country that got into fiscal difficulty because it began a stimulus program and couldn’t take away the stimulus program…”

Bill Bonner unwittingly answered in Tuesday’s Daily Reckoning:

“As far as we know, no democratically elected government has ever been able to reduce its debt burden DURING A CREDIT CONTRACTION”

The rather odd thing about Krugman’s comment is that it illustrates just how clueless he is. He couldn’t spot an example “of a country that got into fiscal difficulty because it began a stimulus program and couldn’t take away the stimulus program” if he was standing in the middle of it. How do we know? He is standing in the middle of it.

Peter Schiff pointed out in a recent video that the areas subjected to stimulus are the ones that collapse as soon as stimulus is withdrawn.

“We had the biggest drop in new home sales in 40 years”

Pending home sales dropped 40%

Only 3% of Americans plan on buying a car – the lowest since records begin (1967)

Hmm, housing and cars. Sound familiar?

Cash for clunkers and homebuyer tax credits – two of Obama’s most touted stimulus efforts.

Daily Reckoning editors have written endlessly about how such stimulus will merely “pull forward demand”, causing a slump once the stimulus is withdrawn. They have been proven right in textbook fashion. But Schiff points out a further crucial consequence of this economic mismanagement.

In addition to pulling forward demand, there is the interest on the debt used to pull this demand forward. In other words, stealing from the future is an expensive exercise. That makes it doubly stupid. But who can blame politicians for not picking up on this, regardless of how obvious it is. After all, an economist might analyse the matter something like this:

And substituting for , we get
So the net nominal effect of = = the interest payments on the amount originally borrowed to stimulate.

“Let us be honest. The US is still trapped in depression a full 18 months into zero interest rates, quantitative easing (QE), and fiscal stimulus that has pushed the budget deficit above 10pc of GDP.”

Pritchard gives special attention to the job market:

“Roughly a million Americans have dropped out of the jobs market altogether over the past two months. That is the only reason why the headline unemployment rate is not exploding to a post-war high.”

“The share of the US working-age population with jobs in June actually fell from 58.7pc to 58.5pc. This is the real stress indicator. The ratio was 63pc three years ago. Eight million jobs have been lost.”

If that is the percent of the working age with jobs, who is supporting everyone else? Oh, that’s right, the US Treasury bond market.

Does this sound rather odd to you? Spending less causes more growth! It shouldn’t sound too unfamiliar. Last week covered the concept. Here it is again, in Trichet’s words instead of the German government’s:

“Confidence is key for growth, and if you cannot have confidence in the sustainability of the fiscal policies then you have no growth because you have no confidence,” he said. “The two things are complimentary.”

Ambrose Evans Pritchard chimes in on the BIS aligning with the new European consensus:

“Last week the Bank for International Settlements called for combined fiscal and monetary tightening, lending its great authority to the forces of debt-deflation and mass unemployment. If even the BIS has lost the plot, God help us.”

The IMF has since reported that the austerity effort in Europe is going swimmingly. Speaking of losing the plot, the US Government is performing right up there.

“Last night, as part of a procedural vote on the emergency war supplemental bill, House Democrats attached a document that “deemed as passed” a non-existent $1.12 trillion budget. The execution of the “deeming” document allows Democrats to start spending money for Fiscal Year 2011 without the pesky constraints of a budget.

“The procedural vote passed 215-210 with no Republicans voting in favor and 38 Democrats crossing the aisle to vote against deeming the faux budget resolution passed.

“Never before — since the creation of the Congressional budget process — has the House failed to pass a budget, failed to propose a budget then deemed the non-existent budget as passed as a means to avoid a direct, recorded vote on a budget, but still allow Congress to spend taxpayer money.”

Deeming something that doesn’t exist into existence is a remarkable feat that only governments (and banks) are capable of.

But it so happens that only the federal government does it in the US. The state governments just stop paying their bills. Illinois’s Comptroller, Mr. Hynes, explains:

“This is not some esoteric budget issue; we are not paying bills for absolutely essential services,” he says. “That is obscene.”

How much of the federal stimulus spending is being offset by this sort of thing?

But if Europe, the BIS, the IMF and Fox and Friends are right, while Nouriel Roubini and Nancy Pelosi are wrong, perhaps stimulus does in fact detract from growth. With the German Jobs Miracle is continuing, Australia has decided to follow suit with impressive employment figures of its own. Considering Australia plans to return to a surplus soon, perhaps austerity is just the rage at the moment…

Going Nuclear

China has ruled out its nuclear option. That means they won’t dump US bonds on the market in an attempt to destroy the US economy. At least they say they won’t, for now.

Apparently, the Chinese government body which administers China’s financial reserves (ironically known as SAFE) said it would be “completely unnecessary” to dump the bonds.

They got that right. The US is imploding either way.

Your editor wrote about the so called nuclear option at university. The argument goes that China will never exercise its power to dump the bonds, as it would undermine its own economy. But countries go on economy ruining escapades all the time. And holding currency and bond reserves gives you a lot of behind the scenes clout. The US was on the other side of the stick once and used its power to influence British and French colonial antics over the Suez Canal. Now, it only takes the Chinese to hint at selling bonds and yields will fly.

That’s why the US has to tread carefully. Poor Timothy Geithner can’t do a Hank Paulson and boss people about. He has to be nice and tactful. Thus, the Chinese are no longer “currency manipulators”.

Glenn Stevens’ Entourage is Growing

Protesting outside the RBA has become more fashionable lately. It began with two Austrian School enthusiasts and now includes the Investors Club, for different reasons. They don’t like the high rates that Glenn Stevens has imposed on them. But it’s the imposition that’s the real problem, not the rate. As Dan explained on Wednesday, it would take sainthood for them to get it right. Let the market decide, not some mere mortal.

Central Bankers Sick of Being Sidelined

“Central banks may be the only remaining line of defence against a scary-but-remote double-dip recession threat,” according to Emily Kaiser at Reuters. That’s why her co-conspirator at the Washington Post reports the “Federal Reserve weighs steps to offset slowdown in economic recovery.” James Bullard from the St Louis Federal Reserve said “You shouldn’t sit on your hands. . . . I think there’s plenty more we could do if we had to.” All this talk has gold bugs and Germans quaking in their boots. Inflation nears.

Governments Investing in Hedge Funds!

Believe it or not, the European funds dedicated to bailing out nations have been safely stored in a SPV run by a former “hedgie” and based in hedge fund central, Luxembourg. And that SPV will be able to borrow 440 bn Euros!

The Economist reports “there remains a remarkable lack of transparency about how it plans to go about its business.” What business is that exactly? And if it borrows, it will have to pay back that money with what revenue?

Forecasting Made Easy

“Consumer borrowing in the U.S. dropped in May more than forecast, a sign Americans are less willing to take on debt without an improvement in the labor market.

“The $9.1 billion decrease followed a revised $14.9 billion slump in April that was initially estimated as a $1 billion increase, the Federal Reserve reported today in Washington. Economists projected a $2.3 billion drop in the May measure of credit card debt and non-revolving loans…”

Economists were $15.9 billion off the first time. 6.8 billion off the second. That’s an improvement of more than 50%! They are geniuses. Sounds like a full blown economic recovery to me!

Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it.
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